An ongoing review of politics and culture

Of Clouds and Silver Linings

I didn’t post anything about the manufactured debt-ceiling crisis because I thought the whole thing was political theater and that the best way to make our politicians stop this sort of nonsense would be to ignore them entirely.

But there is at least a bit of a silver lining: S&P has downgraded American sovereign debt to below AAA for the first time in, to all intents and purposes, forever.

Since the manifest culpability of the ratings agencies in the financial crisis obviously hasn’t done enough to dent their credibility, perhaps this ludicrous decision will be the straw that finally breaks the camel’s back.

Why ludicrous? Because the United States has the strongest credit in the world, as evidenced by the extraordinarily low rates of interest demanded for our debt and by the fact that when there is a financial crisis – even one caused by purported fears of an American default! – investors flee to the safety of . . . American government debt.

You say, apropos of the recent game of chicken between the GOP and the Democrats, that American political institutions have proven themselves to be significantly flawed, unable to deal with serious fiscal challenges. What, praytell, do you think of the vastly more significant game of chicken playing out across the pond between Germany and the more economically troubled members of the Euro zone (particularly Italy)? Why should Germany still be rated AAA when it doesn’t even borrow in its own currency, and faces the potential collapse of its entire banking system if an adequate solution to the Euro crisis is not found?

(Note that I don’t expect any such thing to happen. But I also don’t expect the United States ever to default on its debts. My point is that if I had to compare the likelihood of the collapse of the Euro versus the likelihood of an American default, why on earth – even in the wake of the recent absurdity – would I rate American default more likely?)

The practical consequences of the downgrade by a single agency are minimal, but should Moody’s follow suit we might see an additional silver lining: the collapse of the Basel II/III capital rules. These rules are organized around credit ratings: AAA-rated debt requires virtually no capital to hold. Since, as we learned in the financial crisis, AAA ratings can be manufactured, and since the ratings agencies have proven willing to let themselves be gamed in the manufacture of said ratings, a system like this creates an enormous incentive to pursue such games, and hide risk in the apparently risk-free portion of a bank’s portfolio (which is precisely how the major American banks nearly went under in 2008-2009). But if Treasuries do not get the most favorable capital treatment, then the whole system is obviously absurd. So, hopefully, purportedly risk-free instruments that are not backed by the full faith and credit of the United States government will, in the future, have a more substantial capital charge associated with them, which will reduce the incentive to hide risk in this fashion.

Finally, since nobody else is going to agree with me that the loss of our S&P AAA is a good thing because it discredits the AAA as such, this action by S&P is going to serve as a considerable constraint on future legislative action to increase the deficit (whether by extending tax cuts or enacting new spending programs), for fear that such action would lead to further downgrades. As such, since we are plainly headed towards a double-dip recession, we’re about to get a test of the monetary-policy-_uber-alles_ theories that have been floating around. Because a renewed recession will unquestionably balloon the deficit further. And if the central bank doesn’t take action in the face of both a renewed recession and the prospect of a sovereign downgrade, I think we can safely say that, whatever Chairman Bernanke may have written in his academic work, he doesn’t actually believe he can engineer a nominal GDP recovery.

The Fundamental Problems

This is going to be a fly-by-night post.

The thing that strikes me most about contemporary political debates is how much they arise because of an undiscussed underlying problem: GDP growth.

The main problems of contemporary Western economies is high debt (public and private) and unemployment. The best remedies for both are economic growth. Greece’s debt wouldn’t be a problem if it had high economic growth (or if investors believed it had that potential).

The disquieting rise of extremist politics in Europe would be much ameliorated if there were more jobs, and more growth. Etc.

And yet growth is very rarely discussed or, perhaps worse, only in the context of big government boondoggles like Barack Obama’s plan to boost US exports (what do exports have to do with growth?) or France’s “grand emprunt”.

Ok, so where does economic growth come from? Economics 101 says it comes from population growth and productivity growth. It’s almost a tautology: how much economic value you create comes from how many people you have and how many units of economic value each person create.

Population growth is underdiscussed because the debate about economic growth is dominated by economic policy folks who don’t like to talk about mushy things like that.

But I favor pro-family policies as outlined by e.g. Scene Archdukes Ross Douthat and Reihan Salam in their last book, as well as a “generous” immigration policy.

When it comes to productivity, I believe that the two single most important diagnoses of the problem are this National Affairs article by Scenester Jim Manzi and Tyler Cowen’s book The Great Stagnation (itself heavily inspired by Peter Thiel’s Optimistic Thought Experiment and subsequent pronouncements on the lack of breakthrough innovation).

Ok, so the West’s fundamental problem for the past 30 years has been low population and productivity growth. There are a couple things we can do for population. But productivity remains this mysterious thing.

Cowen/Thiel basically argue that low productivity growth comes from a lack of breakthrough innovation, which itself comes from, roughly, a lack of ambition and a lack of fundamental research.

I think that’s certainly part of it, but I have to say that when it comes to explanations for low productivity I turn to Matthew B. Crawford’s Shop Class As Soulcraft and Amar Bhidé’s Venturesome Economy.

Despite their seemingly very different subject matters, I believe those two actually are spotlights on different aspects of the same problem, which happens to be the key to higher productivity growth. And I would argue that the problem is a fundamental mismatch between raw ability and opportunity.

They both highlight the fundamental bankruptcy of the 30 year old Grand Strategy of the West in dealing with Globalization, which is the creation of a supposed Knowledge Economy of college-educated workers.

It turns out, this Knowledge Economy is really a 19th century industrial economy where physical widgets are replaced with “ideas.” The reason why the Grand Strategy is bankrupt is that most corporate white-collar work is actually more displaceable by outsourcing/technology than small-scale, global-reach entrepreneurship, whether it involves fixing motorcycles or building tables (Shop Class) or making yoga pants (Venturesome Economy).

We are taking raw material in the form of middle-class 18 year olds in Ohio, putting them in conveyor-belt colleges and conveyor-belt jobs like bank teller, travel agent, accountants, claims adjusters, “engineers” and so forth which can and will be done better, faster and cheaper by computers and/or eager Indians. The Knowledge Economy “works” (for how long?) for the Harvard-McKinsey conveyor belt who will, in any case, always land on their feet, whether through accumulated social capital or human capital. It does not, however, work for the Median Public University-Big Regional Company conveyor belt.

Peter Thiel’s venture capital firm Founders Fund is investing in breakthrough company SpaceX that wants to turn humanity into a spacefaring civilization. SpaceX is not doing this, however, by inventing breakthrough spaceship technology. It is doing this by using very well-understood, old technology — rockets — and making them much cheaper and usable. It is, in other words, not a scientific innovation company, but a process and business model innovation company. It is building Hondas in space , not The Phoenix . (And by the way, who is going to build the first useful flying car? A PhD in a lab coat or a passionate, shop-class type mechanic who will teach himself the requisite physics through Khan Academy (process innovation!) and fund himself through credit cards (financial innovation!)? I would bet on the latter.)

There is no lack of resources for fundamental research, which provides the open source toolkit for breakthrough innovation. But there is a serious mismatch between raw ability and skill and opportunity for building breakthrough innovation through process and business model and marketing innovation a la SpaceX.

So this is a roundabout way of saying that I think we would go a long way towards improving productivity growth by, first and foremost, building decentralized, talent-focused knowledge-signaling systems, and fostering an open, decentralized, entrepreneurial economy with more venturesome consumers and entrepreneurs, and more venturesome soulcrafters.

Of course it’s all easier said than done.

But I guess the crucial point here is that it’s too easy to believe we need a deus ex machina, like “breakthrough innovation” and flying cars to get ourselves from our rut. But the flying cars won’t come from a skygod, whether in the guise of Big Government, Big Science or Big John Galt.

We have the tools we need. The problem is that hundreds of millions of people have great latent talent which is not being recognized (even by themselves) and validated and met with opportunity. The problem, as always, is to let a thousand flowers bloom.

Objective Scarcity and the Paradox of Productivity

In general, if you care about equality, you ought to be passionate about scarcity. As long as there’s not enough of some valuable commodity to go around, then whoever’s richest is going to end up getting it even if the income distribution is relatively flat. By contrast, when you make some category of goods plentiful, you necessarily end up curbing inequities. These days all kinds of Americans can afford a good television. Tragically, though, many Americans can’t afford a house in a safe neighborhood with a decent school that’s within a convenient commute of the central business district of a major city.

That’s Matt Yglesias again, pointing out (correctly) that just because Americans have plenty of food and cheap entertainment relative to just about any period in the past, that doesn’t mean there’s no such thing as poverty.

His solution to the problem of scarcity of good schools and safe neighborhoods, though, is to make more slots available for both – build more housing in good neighborhoods and make good schools educate more children. And this implicitly assumes that opening up more slots won’t change the character of either the schools or the neighborhoods – an assumption that sounds wrong on its face and that many would argue has been disproven in practice repeatedly (most dramatically with the failure of busing).

Here’s the thing. You can improve performance at a single school by attracting a higher caliber of student and/or a higher caliber of teacher. Similarly, you can make one neighborhood safer by attracting a higher caliber of resident and/or improving policing. But the only way to make all schools better in aggregate is to improve the caliber of students and/or teachers generally. The only way to make neighborhoods safer in aggregate is to improve the caliber of residents and/or improving policing generally.

And increasing the number of available slots in good schools or safe neighborhoods can only do this indirectly if at all. The implicit assumption seems to be that new students and residents will acculturate to their new schools and neighborhoods. But it’s at least as likely that the schools and neighborhoods are what will change – for the worse. If you recognize this, then what you have to be arguing for is not simply increasing slots, but giving greater scope and authority to good institutions. Give management of a high-performing network of schools the opportunity to take over a failing school. Give the precinct commander who’s cleaned up a tough neighborhood the job of police chief in a small city. And so forth. But even as you do these obvious things, you’re going to discover that these highly-effective managers succeed in part by selecting good personnel, personnel they select from a larger pool. And if they do a better job of getting rid of lousy teachers or cops, those people go elsewhere. And some other school or precinct gets just a little bit worse.

Public policy has limited leverage over the overall caliber of the student body or the resident population (immigration policy is one of the few levers it does have). It obviously does have some leverage over the quality (and quantity) of teachers and police officers, but even this leverage is relatively limited, and not only by obstructive unions or whatever your particular bugaboo is. It’s limited because talent is the scarcest commodity there is. And the price of talent is driven, most fundamentally, by productivity.

The paradox alluded to in the title of this post is that the cheap television sets are, in a very real sense, the cause of objective scarcity in schools. Productivity growth in big swathes of the economy has made our society objectively richer. In many, many professions, a single individual can generate much more output per hour than he or she could a generation or two generations ago. Teaching and policing, though, have experienced much less productivity growth than the economy as a whole. As you would expect, competition for employees with more productive sectors of the economy has resulted in rising costs combined with declining quality.

We could improve the quality of the teaching and/or policing pool nationwide by the combination of higher spending and more intelligent recruitment, training and management techniques. The result would be an overall better pool for these occupations, which should improve the quality of the service. On the other side of the ledger, we’d experience a deterioration in personnel quality in some other sector in the economy – which might be a good tradeoff depending on what that sector was. But even that will only buy us time. Costs will rise inexorably, and the more concerned we are with maintaining the quality of the labor pool in these essential services, the faster they will rise.

There are only three ways to avoid this trap. One is to cease pursuit of, or even reverse, productivity gains elsewhere in the economy. If the economy as a whole became less productive, professions like teaching would become more attractive – even at relatively lower wages. (It is worth noting that the Soviet Union had a very highly regarded schools system.) On the other hand, productivity is the most important driver of increases in national wealth, and so long as other countries are pursuing national wealth, our national power depends very directly on successfully competing with them. (It is worth noting that the Soviet Union no longer exists.)

The second is to reduce the quantity of the service. Quality of live theater, for example, or of live orchestral music, has arguably remained high in spite of Baumol’s cost disease because there is simply less live theater and fewer orchestras around than there used to be, and they charge high enough prices to maintain high quality. Similarly, we could just teach fewer kids. Police fewer neighborhoods. To some extent, this is precisely what has occurred. This approach amounts to the secession of the more productive sectors of society from the rest of society, which will get progressively worse-educated and less personally secure. It is not an impossible outcome, but it is one that should be abhorrent to anyone with remotely progressive sentiments, or, really, any sense that we ought to have some degree of solidarity with our fellow citizens.

The third alternative is to pursue productivity gains in professions like teaching that have not experienced many such gains historically. There’s some low-hanging fruit here – better teaching and classroom-management techniques can increase the quality of instruction in a given period. Similarly, good collection and use of data can significantly improve the impact of policing by putting cops where they are most needed. But once that fruit is plucked, it’s not clear where you go for additional gains. Recall what productivity means: it means more output per hour. If we’re talking about teaching, that means getting more instruction out of each individual teacher/hour. This is much more difficult to do with teaching than with manufacturing – that’s why we haven’t done it. But that’s the question we have to be asking. (Yglesias has suggested in the past that smaller classes may make schools worse in aggregate because it means hiring more teachers which means, on average, worse teachers. But in the absence of productivity-enhancing innovations, there’s no reason to think that bigger classes would be better – rather, there’s some class size beyond which performance starts to deteriorate for any teacher.)

I’m on the board of a charter school. I believe that letting strong personalities create institutions, giving them scope to achieve their goals and holding them accountable if they don’t, is the way to grow strong institutions, and that strong institutions will deliver better services than weak ones. (And I believe that public policy has a variety of levers to make sure that these institutions genuinely serve everyone, as public institutions must, and should use those levers.) But I also recognize that “do more of what works” is a much, much more difficult mandate than boosters seem to realize.

Roll Over

Matt Yglesias points out correctly that Chinese ownership of American debt doesn’t give them the ability to repossess, thereby refuting a John Stewart joke.

But while massive foreign ownership of American debt doesn’t give foreign powers the “right” to take over the country (nor the ability), it does give them considerable leverage over the policies of the United States government.

That’s because the debt has to be rolled over. We’re not going to pay it off. We shouldn’t want to pay it off. (Ever.) So when it comes due, we’ll need to sell new debt to pay off the old principal. And that new debt will pay interest at then-prevailing rates. We need buyers of American debt in large numbers to exist in the future, or we won’t be able to roll the debt over at attractive rates (which means we’ll be paying more in taxes to service the debt).

Now, this would all be true whether the buyers of government debt are domestic or foreign. But if the buyers are domestic, then the whole “tax to pay interest” thing is a domestic redistribution question: who is to be taxed to pay interest to whom. There are a variety of ways to settle these kinds of questions, but none of them have direct foreign policy implications.

But if the debt is held substantially by foreign powers, then higher interest rates mean paying more taxes to those foreign powers.

Our dependence on foreign debt purchases is rather like our dependence on foreign oil. Because we consume so much oil, cannot easily switch to other fuels, and purchase so much of it abroad, we have an interest in places like Saudi Arabia. And these countries do have some ability to influence our foreign policy – more than they would have if we were an oil exporter or if we used nuclear fusion to meet our energy needs. Similarly, if China is the overwhelmingly dominant buyer of American federal debt, then China’s decisions about what the right price is for that debt – what interest to demand – will be the most important factor in determining what the price actually is. And that gives them leverage over the United States government.

Yglesias wonders all the time why we have such a pronounced policy preference for disinflation, across both parties, even when inflation has been below target and unemployment has been really high. There are a variety of reasons – the fact that the ECB is even more paranoid about inflation, for example; the fact that unemployment isn’t afflicting a true cross-section of the American public; the vastly expanded political influence of the financial sector – but I’ve long felt that one reason is that we have to keep the Chinese happy because we need them to keep buying our debt. Let’s put it this way: when was the last time you heard a Chinese official say that America needs to do more quantitative easing to spur growth, because they are worried that too much austerity will impair our ability to pay back the debt they own? Never? Correct. Because the odds of truly defaulting on our debt are virtually zero, never mind the current Washington shenanigans, whereas the odds of inflation eating away at the value of the debt owned by the Chinese are to some extent positive. Disinflation-above-all is the preferred policy for somebody who is a substantial creditor to the United States and in no sense an equity holder.

Yglesias thinks it would be better for the Chinese to buy less American debt. I agree, although the way I would put it is that it would be better for both the Chinese and the Americans for China to raise its level of domestic demand and lower its savings rate. But this would require Americans to generate more savings to compensate, otherwise interest rates would go up, making rolling our enormous debt more expensive. And raising savings rates is contractionary. There’s not a way around this. Many of the things we need to do for the long term health of the country – for example, reducing our dependence on fossil fuels and reducing our dependence on foreign credit – are contractionary in the short term. Goosing inflation expectations will lower domestic savings when we need to be raising it. Goosing demand will increase demand for imported oil when we need to be reducing it. What Yglesias thinks is the optimal policy response to the tragedy of persistently high unemployment – namely for the Fed to engineer higher inflation expectations to boost domestic demand – digs us further into our long-term hole. Higher domestic demand means lower domestic savings which means an increased dependence on Chinese purchases of domestic debt. Higher inflation expectations mean higher long-term interest rates (which means more of our taxes going to pay interest, and less to providing services to the American people) or, if interest rates remain low, that implies that higher inflation expectations are being offset by lower real growth expectations, and it’s real growth that makes us wealthier.

“I just stay in bed if no one calls me”

Yesterday’s Wall Street Journal had an uplift piece on using gee-whiz data analytics to improve Chicago’s public schools. I found it incredibly depressing. Here is how the article opens:

At 7:15 on a chilly May morning, Marshall Metro High School attendance clerk Karin Henry punched numbers into a telephone, her red nails clacking as she dialed.

“Good morning, Miss MeMe,” she said to Barbara “MeMe” Diamond, a 17-year-old junior with a habit of oversleeping. “This is Ms. Henry, your stalker.

The timing of the call was key. Earlier in the year, Ms. Henry and a co-worker were spending nearly two hours a day calling every student who hadn’t checked into school by 9:30 a.m. But weekly data tracked by their office found that only about 9% of those students ever arrived. So they changed tactics, zeroing in on habitual latecomers like MeMe, and delivering wake-up calls starting at 6:30. On that May morning, 19 of the 26 students called showed up.

“I just stay in bed if no one calls me,” MeMe said. “That 6:30 call be bugging me, but it gets me here.”

Here is how the article ends:

Sharief Raines, an 18-year-old senior with a toddler at home, took the challenge after missing every school day in December. In January, she showed up 12 of 19 days. Ms. Calhoun even watched the baby one afternoon while Sharief did homework. “I saw Dean Calhoun was trying to help me,” she said. “I didn’t want to let her down.”

Sharief graduated June 11.

The attendance clerk sounds like somebody getting into the office early to get her job done, and I assume that both MeMe Diamond and Sharief Raines have faced enormous obstacles in their lives. I say this without malice, but no school is going to solve the problems of many students like this. This school exists within a sea of dysfunction that it cannot fix.

The implicit frame of reference that is normally used for these kinds of stories is the history of the communities and families in question, or the “good” suburban schools around them. Mine is different.

Globalization has created trans-national labor pools through a mix of literal outsourcing, immigration and importing labor content via shipped manufactured goods. We move the people, the jobs or the merchandise; but either way, workers in Illinois must increasingly compete with workers who live in Eurasia or have immigrated here from Latin America and elsewhere. These are no longer poor people “out there somewhere” for whom we should feel pity and give foreign aid, but people with whom, one way or another, our hourly pay is being compared by those who will decide where new jobs go. Today there are probably hundreds of millions of people on one side of the relevant labor pool who have such a different orientation toward school that the worry is that they’re working too hard, and hundreds of millions of low-skill competitors on the other who are prepared to work for wages much lower than those of even very poor Americans.

Within less than one year, MeMe and Sharief will have to compete in that environment. There is no fixed lump of labor. By specializing in what we do best, and then trading with ever-larger numbers of others who can afford to buy our output, we can become wealthier. What will MeMe and Sharief specialize in? Who in an open market will pay enough for their time to create sufficient income to support them (and Sharief’s child) in a humane manner? (It’s easy to read this as scornful, but I really just feel sympathetic, in that if dealt the same hand of cards, I think I would be in pretty much the same place.)

By extension, where are large chunks of the American labor force are headed? How much dysfunction can the productive economy carry on its back as the level of global competition rises ever higher?

The answers to all of these questions are, in my opinion, very troubling.

I don’t have any great solutions, but then again, I don’t think anybody else does either. “The Answer” is probably not there to be found. I doubt there are any silver bullets, just lots and lots of scut work in many areas, each of which can make a small contribution.

“Data-driven schooling,” if done with this perspective in mind, can certainly make an incremental positive contribution. But it’s easy to do it in a way that actually makes things worse.. If focused on short-term carrots-and-sticks that ignore character effects; if divorced from the right incentives for the participants; and if not focused on careful evaluation of the actual success or failure of interventions against validated outputs, it’s likely to be a huge waste of scare time and money.

(Cross-posted to The Corner)

A U.S. Manufacturing Strategy, Part 2

This continues from the prior post, which argued that the U.S. government ought to care a whole lot about absolute and relative American productivity growth.

Proposition 2: Not all kinds of productivity growth are created equal

I’ll illustrate two different kinds of productivity growth with practical examples from my experience in the manufacturing industry. I once invented a new production planning algorithm (essentially, the decision rules for which products to make when, and in what sequence) that improved the output of a specific factory by about 5 percent. This is pure gravy: the same people show up at the same factory and work the same number of hours, the same raw materials are purchased and so on, but the world just gets 5 per cent more widgets out of the other end. This is normally the kind of thing most people picture when they use the term “productivity growth” in normal speech. On another occasion, I figured out the financing that made it profitable to shut down an entire factory, and sell the land to a property developer. This is normally the kind of thing that most people mean in normal speech by “the locusts of private equity.” I’ll call the first example an improvement in “operational efficiency” and the second example an improvement in “allocative efficiency.” In fact, both are necessary for ongoing improvements in productivity and wealth for an advanced economy.

Let me describe the decisions around these kinds of changes from the point of view of a business owner or executive. In somewhat simplified terms, if I’m doing stuff that earns returns below my cost of capital, or if I can get someone else to do it for me at lower cost than I’m doing it, it makes sense to cut out the activity. These cut activities will tend to be those with lower productivity. Cutting activities for shareholder value reasons will therefore strongly tend to cut low-productivity activities, and increase my firm’s average productivity through pure “high-grading.” But this ignores at least a couple of important questions. First, did I fail to uncover economically achievable improvements in operational efficiency that would have allowed me to conduct these activities at higher returns and cheaper than alternatives? Second, are the cut activities linked in some non-obvious way, and potentially only over time, to the other more profitable activities, such that I have fooled myself into putting the profitable parts of the business at risk?

A business culture that ignores these questions can tend to get into a death spiral of endless high-grading against an ever-rising tide of competition that eats the business one bite at a time. The fear of many critics of American business (or “Anglo-Saxon financial capitalism”) has for a long time been that this is what is happening to the American economy on a grand scale.

And further, at the level of the entire society, while a firm can get more productive by high-grading, if the alternative employment for the people who used to work at the closed factory is collecting unemployment checks, can’t this become a society with an ever-shrinking base of people with high-paying jobs? This is the nightmare scenario of an ever shrinking number wealthy financiers, who are increasingly detached from a broader society all around them living off a combination of table scraps and handouts.

There is something to this fear. But on the other hand, the failure to allocate capital and labor from kinds of activities where there are inherent limitations to how productive they can be to those where they have greater inherent productivity will also hurt productivity growth in the long run. The key word in that sentence is “inherent.” The more we can take what is currently viewed as inherent productivity by analysts, economists and others, and improve it by unanticipated innovations, the more we can have allocative efficiency without giving up as many manufacturing jobs.

Think of operational efficiency as getting better at playing a given game, and allocative efficiency as deciding what games to play. We need both. We want to have an economic regime such that the people working a specific line in a given plant work as hard and as smart as possible to get that line to be as productive as possible; such that the management of that plant is allocating resources among the production lines, and thinking hard about the overall production process such that they make that plant as productive as possible; such that the company is doing the same thing at a yet-higher level for its collection of factories, warehouses and sales offices; and such that the economy as a whole is allocating resources across firms intelligently.

In fact, when we move from the level of the individual firm to the economy as a whole, the nature of the process of resource allocation should change. If, following Coase, we very crudely define the boundaries of the firm as the maximum extent of activity for which central planning can work effectively, then we need to use markets to allocate resources across firms. The unique virtue of markets is not so much in their allocative efficiency, as in what Douglas North termed their “adaptive efficiency”: basically, discovering entirely new ways of organizing resources. If allocative efficiency is deciding what game to play, adaptive efficiency is inventing entirely new games. Adaptive efficiency is not nearly as important for an economy in catch-up mode, but for an advanced economy, it is essential for productivity growth.

We can think of a hierarchy of kinds of productivity growth, with operational efficiency at the foundation, then allocative efficiency next, and finally adaptive efficiency as the master-allocator of resources. We then need to think about manufacturing strategy in the context of the need for the combination of operational efficiency, allocative efficiency and adaptive efficiency that will create rapid, continuing productivity growth in the economy as a whole. In effect, adaptive efficiency – which, all else equal, is likely to continue to squeeze out manufacturing jobs – needs to be the evolutionary principle by which the economy creates productivity growth, but efforts to improve operational efficiency within manufacturing will change the set of “givens” (for example., the relative profitability of in-sourcing versus outsourcing) that this evolutionary process will confront.

The next post in this series will try to sketch out some ideas for what I think is most likely to help do this.

(Cross-posted to The Corner)

A U.S. Manufacturing Strategy, Part 1

There has been an interesting ongoing blogosphere dialogue on the role of manufacturing in creating high-wage jobs in America, involving Paul Krugman, Reihan Salam, David Leonhardt, Karl Smith and Michael Mandel, among others.

This topic has been a fixation of mine for a very long time. Here is how I opened an article a couple of years ago in National Review:

I still remember the first time I walked into a working factory. In the foreground, innumerable machines whirred and clacked away in precise, interlocking dances. A massive vat shaped like a 50-foot-tall Campbell’s soup can loomed in the background. It was encased in a protective sheath of refractory bricks that glowed dusky pink with trapped heat. A crane arm dumped heavy sand continuously into the top at (literally) industrial volumes. Steaming, liquid glass gushed out of the business end at the bottom in a matching stream. I couldn’t see the heating element, but it was in there somewhere, and it was working. …

I was looking at concretized human ingenuity. In the auto industry, “car guy” is a slang term for an executive who doesn’t just view the business of a car company as making money, but loves the cars themselves. I’m a factory guy.

I spent the first few years of my career in the 1980s as one small part of a self-conscious movement to rescue American manufacturing from its projected obsolescence. I’ve worked in glass plants, assembly plants, oil refineries, and textile plants from Florida to Canada, and many points in between. I’ve carried a union card and walked a picket line.

I’ll put forward several propositions as being as being relevant to this discussion. (This would be a very long blog post, so I’ll break them up into several posts.)

Proposition 1: Competitiveness is productivity

Professional economists often pooh-pooh the importance of national competitiveness. To quote Krugman:

The growing obsession in most advanced nations with international competitiveness should be seen, not as a well-founded concern, but as a view held in the face of overwhelming contrary evidence.

They will point out that we all gain from trade, and as people in other places get richer, so can we. Countries, they say, are not like corporations.

Maybe so, but it’s still the case that some societies are populated by lots of people with high wage jobs, nice houses and good schools, and other societies are populated by lots of people hustling for tips from vacationers from the first kind of society. Over time, people who spend their working hours generating goods or services that they can sell for a big margin versus the costs of the required inputs will tend to live in the first kind of society. Nothing is forever in this world, but I want America to remain in that camp for a very long time.

This doesn’t occur by immiserating other societies – international economic competition is not zero-sum in that sense. But there are many paths open to us for how we react to the rise of non-Western economies, some of which lead to us being much better off than others, both in an absolute sense, and also in a relative sense.

Relative productivity is likely to matter a lot, because it will materially influence future absolute wealth by affecting the flow of global technology and innovation. But relative productivity and wealth also matter in and of themselves. First, they will impact the global prestige and success of the Western idea of the open society which we value independently of its economic benefits. Second, maintenance of a very large GDP per capita gap between the West and the rest of the world will be essential to maintaining relative Western aggregate GDP, and therefore, long-run military power.

In sum, we want the rest of the world to get richer, but we want to stay much richer than they get.

This demands that we sustain rapid productivity growth over many decades. Unfortunately for us, this is much harder to do for an advanced economy than for those in catch-up mode, and is likely to continue to create very tough social strains in America. Perhaps we’re just not up to it. This, and not some lets-all-succeed-equally-together happy talk, is the real meaning of globalization for America in 2011.

(Cross-posted to The Corner)